Earnings Call Transcript - BFAM Q3 2024

Michael Flanagan, VP, IR

Greetings, and welcome to the Bright Horizons Family Solutions Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. It is now my pleasure to introduce Michael Flanagan, Vice President of Investor Relations. Thank you. You may begin. Thanks, and welcome to Bright Horizons' third quarter earnings call. Before we begin, please note today's call is being webcast and a recording will be available under the Investor Relations section of our website. As a reminder to participants, any forward-looking statements made on this call regarding future business, financial performance and outlook 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 should be considered in conjunction with the cautionary statements described in our earnings release, 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. Today, we will also refer 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. Joining me on today's call are Chief Executive Officer, Stephen Kramer; and Chief Financial Officer, Elizabeth Boland. Stephen will start by reviewing our results and provide an update on the business. Elizabeth will give a detailed review of the numbers before we open it up to your questions. With that, let me turn the call over to Stephen.

Stephen Kramer, CEO

Thanks, and good evening to everyone on the call. Before we dive into our financial results, I want to extend our heartfelt sympathies to everyone affected by Hurricanes Helene and Milton. While the overall operational impact for Bright Horizons was quite limited, these storms have had a profound effect on many of our educators, families, and clients in the affected areas. The devastation is truly heartbreaking, and our thoughts are with those impacted. In the face of unimaginable challenges, however, the Bright Horizon spirit has continued to show through as employees across the South and Eastern U.S. stepped up to support our clients, families, and communities during this challenging time. Their dedication and resilience in the face of these natural disasters is truly inspiring. Thank you for embodying our core principles and showing such unwavering commitment. Moving on to our results, I was pleased with our overall performance in the third quarter. Total revenue and adjusted EPS came in better than we expected, driven largely by our back-up care segment through stronger use, revenue, and margin performance, while full service and Ed Advisory were generally in line with our expectations. Overall, I am proud of our performance so far in 2024, and we are set up well to close the year with strength. To get into some specifics on the third quarter, revenue increased 11% to $719 million with adjusted EBITDA up 20% to $121 million and adjusted EPS growing 26% to $1.11 per share. In our full service child care segment, revenue increased 9% to $487 million. We added six centers in the third quarter, including client centers for Colorado School of Mines, Regeneron Pharmaceuticals, and Yale New Haven Health System. Enrollment in centers opened for more than one year increased at a low single-digit rate in Q3 across our U.S. and international operations. An average occupancy percentage followed its typical seasonal pattern stepping down sequentially to the low 60s. The U.K. continued to make operational and financial progress in the third quarter, narrowing its losses compared to last year. There is still a lot of work to be done in the U.K. to return our operations to pre-pandemic performance levels and beyond, but this year's gains have been particularly encouraging following the challenges of 2023. I continue to be confident that we have established a solid foundation and set of initiatives to drive continued improvement in 2025 and beyond. Let me now turn to Back-up Care, which delivered another outstanding quarter. Revenue increased 18% to $202 million, outpacing our expectations for the quarter on stronger employee engagement and usage. We also continue to expand our client base with new employer launches, including Progressive Corporation and Brookfield Property. Growth in back-up usage was robust across traditional care types with notable strength in centers and camps as the care needs for school-age children are particularly acute over the summer break. As we have spoken about in the past, the supply of care is a critical element to achieving our back-up growth goals. The operations team again performed exceptionally well this quarter, delivering on the supply to meet another record level of usage over the short summer period. The investments we have made and continue to make in building supply, new care types, and personalized market and technology initiatives are bearing fruit and position us well to deliver on our growth goals in the years ahead. Our Education Advisory business grew to $31 million in the quarter. We added new clients to the portfolio, notably launching Enterprise Holdings and Rice University. However, as we have discussed for the last several quarters, participant growth in our EdAssist business remains muted. We are continuing to make investments in the team, product, and marketing to revitalize our participant growth in 2025 and beyond. Before I wrap up, I want to highlight the incredible success of our Omni Horizon Summit, our first in-person client event since the pandemic. We were thrilled to welcome clients from across the country and across industries, including leading employers such as Accenture, J.P. Morgan Chase, and Valero. There was a wonderful opportunity for clients to visit our home office, including the June Greenman Early Education Innovation Center, network with each other, and hear from HR executives and Bright Horizons leaders who underscored ways that our services support client employees' care and education needs. This summit reinforced our commitment to innovation and excellence in employee engagement and productivity, solidifying our position as a leader in the industry. In closing, I am encouraged by the continued growth and high-quality operational delivery we are seeing across our business. Given our results year-to-date and our current outlook for Q4, we are refining our full year revenue guidance to be approximately $2.675 billion, representing 11% growth and an adjusted EPS range of $3.37 to $3.42. With that, I'll turn the call over to Elizabeth, who will dive into the quarterly numbers and share more details around our outlook.

Elizabeth Boland, CFO

Thank you, Stephen, and hello to everyone on the call. To summarize the third quarter, overall revenue rose 11% to $719 million. Adjusted operating income was $89 million, or 12.4% of revenue, which is a 34% increase compared to the third quarter of 2023, while adjusted EBITDA was $121 million, or 16.8% of revenue, marking a 20% rise from the previous year. We finished the quarter with 1,028 centers, having added six and closed ten. Full-service revenue reached $487 million, up 9% in Q3 due to pricing increases and slight enrollment growth. As Stephen noted, occupancy levels for our portfolio that has been open for over a year averaged in the low 60s for Q3, decreasing sequentially as expected during the summer season. We are seeing improvements in our previously discussed center cohorts compared to the past year. In Q3, our top-performing cohort, identified as those above 70% occupancy, increased from 36% of our centers in Q3 of 2023 to 42% in Q3 of 2024. Our lowest-performing cohort, those under 40% occupancy, now comprises 13% of centers, down from 17% the previous year. Adjusted operating income in the Full Service segment rose by $5 million over the past year to $12 million. Increased enrollment, tuition raises, and better operating leverage, particularly in our U.K. operations, compensated for the $9 million decrease in support from the ARPS government funding program in Q3 of 2023. Revenue from our new back-up care service grew 18% to $202 million in Q3, surpassing our anticipated growth of 11% to 13% thanks to stronger usage, leading to an adjusted operating income of $70 million in Q3 of 2024, which was 35% of revenue. Additionally, revenue in the Educational Advisory segment rose 4% to $31 million, yielding an operating margin of 21%. The slight decrease in operating margins in Q3 compared to the prior year reflects our ongoing investments in this segment. Regarding the income statement, net interest expenses were $12 million in Q3 of 2024, resulting from lower average borrowings but offset by higher net rates on our outstanding debt compared to Q3 of 2023. The structural effective tax rate on adjusted net income was 27.5% this quarter. On our balance sheet and cash flow, we've generated $217 million in cash from operations through September, up from $161 million last year. We invested $65 million in fixed assets in 2024, similar to the $60 million from the same period in 2023. By the end of the quarter, we had $110 million in cash and reduced our leverage ratio to 2.1 times net debt to adjusted EBITDA. Moving to our outlook for 2024, we are narrowing our guidance for revenue and adjusted EPS, reflecting our strong performance in Q3. We now anticipate revenue to be around $2.675 billion, with adjusted EPS projected in the range of $3.37 to $3.42 per share. By segment, we expect full-service revenue to increase approximately 10% to 11%, back-up care to grow 14% to 15%, and Educational Advisory to remain relatively flat compared to the previous year. This full-year forecast suggests Q4 revenue will be between $665 million and $675 million, with adjusted EPS anticipated to range from $0.88 to $0.93 per share. With that, we are ready to proceed to the Q&A.

Andrew Steinerman, Analyst

Hi, Elizabeth. Could you just tell us what your organic constant currency revenue growth was in the third quarter post the center closings that you mentioned? And then also mention if there have been centers acquired through M&A over the last 12 months.

Elizabeth Boland, CFO

Sure. So overall, the full service revenue growth was 9.4%. Organic constant currency would have been 8%. The FX was around 100 basis points and M&A was about 50 basis points.

Manav Patnaik, Analyst

I think you mentioned that total enrollment growth was low single digits. I know in the past, you've given us what the U.S. growth was and even what infant and toddler and the older age group was. I was hoping you could just give us that breakdown just to track how enrollments went this time.

Elizabeth Boland, CFO

Yes. So broadly speaking, Manav, enrollment was pretty consistent, both domestically and internationally in that low single digits range. Infant and toddler enrollment has been stronger as we've talked about the last couple of quarters, and it's coming more in line with the growth that we're seeing with preschool. So broadly speaking, those statistics kind of came in line, which is why we didn't isolate them.

Manav Patnaik, Analyst

Okay. Got it. And then I know it's still early, but just when we look out into '25, any moving pieces that perhaps you'd want to call out? I know it's early to give set guide ranges, but just trying to get a first peek there.

Elizabeth Boland, CFO

I think your question was about our outlook for 2025. I'm sorry, I didn't quite catch that. Yes. It's still early for us to provide full guidance for 2025, but as we approach the end of the year and finalize our budget, we have some insight into our thoughts. For the second half of this year, we reported low single-digit enrollment growth for Q3, and we expect this pace to continue through the rest of the year, including Q4. We anticipate enrollment next year to also be in the low single digits. Average price increases have been around 5%, but we expect this to taper to about 4%, with a 100 basis points gap between tuition and wage increases. This will affect our key performance indicators. Backup growth has been strong, projected at 14% to 15% for the full year. However, after several sequential quarters of performance, we expect to return to our historical range of low double digits, around 10% to 12%, while sustaining our operating margin performance, which may be slightly less robust given top-line growth in that area.

George Tong, Analyst

Hi, thanks. Good afternoon. Can you discuss what your expectations are for occupancy rates by the end of this year and the timing for when overall occupancy rates will recover back to pre-COVID levels in the 70% range?

Elizabeth Boland, CFO

Sure, I'll break it down since it's not a completely straightforward answer. Overall, we expect our utilization to remain in the low 60s for this quarter and into the rest of the year. We anticipate ending the year also in the low 60s. Historically, our peak usage occurs in Q2, so we expect to build back up to that level in the first half of next year. As mentioned, the top performers among our centers are already at maximum enrollment occupancy, so there isn’t much room for growth there. The enrollment increase will mainly come from about 55% of the centers that are still working to reach pre-COVID occupancy levels. We expect good progress from the mid-performing centers, getting closer to those levels by 2025. The bottom tier is less clear, and it’s too early to predict when they will fully recover since around 10% to 15% of centers are still under 40% occupancy. This group is facing more challenges in generating enrollment momentum. While they're seeing some gains, they're starting from a very low base, making it a slow journey back towards the 60% to 70% occupancy range.

George Tong, Analyst

Got it. That's helpful. And just to elaborate on that last point, what would you say is the key challenge around the momentum in that bottom cohort? Is it the work-from-home dynamic? Is it geography? Like where these centers are operating? What are some of the commonalities that this bottom cohort of centers have that you could perhaps address in trying to drive improvement in occupancy?

Stephen Kramer, CEO

It's a great question. We've spent considerable time analyzing the bottom cohort and the centers within it. I would say there's no clear pattern regarding micro-geography or the operational aspects you might typically consider for an operating center. There is definitely a segment that serves as client centers, and overall, our client centers have higher occupancy rates than our lease consortium centers. However, there are also some that function as client vendors, which depend on client discretion, meaning we earn a fee for those centers. If they are underutilized, that decision lies with the client. Furthermore, within the lease consortium, there is an imbalance between the number of centers in the U.K. compared to the U.S., as we see more centers in the U.K. relative to the size of the portfolio there. Despite this, we have observed some improvement. While we would love to provide a prototype for what constitutes underperformance, we are taking specific actions for each center and treating them individually as we work toward improvement.

Jeff Meuler, Analyst

Yes. Thank you. Good afternoon. I mean, it makes sense to me that the enrollment trends would be normalizing towards the long-term average as you have more pockets of capacity constraints and more centers in the greater than 70% occupancy bucket. But can you give us a sense of the trends in the 40% to 70% occupancy bucket? Like what is the same-store sales enrollment growth just in that cohort and has it been slowing at all?

Elizabeth Boland, CFO

I think the key point is that our average enrollment is in the low single digits, with our top cohort performing well and growing in the 0% to 1% range due to high enrollment. The middle cohort is at mid-single digits, and we have the opportunity to continue building on that steady progress. However, there are some capacity limitations regarding how children fit into the available rooms. Nevertheless, there is still good momentum in that group for continued enrollment. The lower cohort, which is under 40% enrolled, shows the most growth percentage-wise, but it consists of fewer centers and while the percentage growth appears significant, they are still quite distant from reaching the 50% to 55% breakeven point.

Jeff Meuler, Analyst

And I guess in the middle cohort, has the growth been holding steady? Or as you went through the back-to-school process this year? Was there any deceleration or acceleration?

Elizabeth Boland, CFO

I think it's been relatively steady. There is a little bit of enrollment turnover at this time of year due to seasonality, but we've returned to a more typical seasonal pattern. We did experience somewhat slower growth this year, but it wasn't a significant decline.

Jeff Meuler, Analyst

Got it. And then was there any meaningful impact either in Q3 or in Q4 from self-sourced reimbursed care? And I know you said the operational impact of the hurricanes financially was not overly impactful, but did you see any sort of discernible impact on full-service enrollment transfer? Thank you.

Stephen Kramer, CEO

Yes. I think you were asking about on backup, whether or not we saw self-source care and then also transition to full-time care in terms of enrollment. I think on the backup side, we continue to see a deceleration on the use of what we would call self-source care. And that shift has meaningfully gone towards our traditional care types. So from our perspective, that's a really positive trend because obviously, in the depths of COVID where we didn't have the network to be able to support the need, we then were providing the financial resources for people to find it on their own. On the other hand, what we are best at and what we are really proud of is when we can actually deliver the care. And so we've seen definitely a decrease. We did not see a spike in out-of-network care during this quarter, nor did the hurricane sort of bring that out in any meaningful manner. So really, the spike that we saw in Q3 was because of the need for centers and camps and then in-home care. In terms of enrollment, again, we didn't see any meaningful change in terms of people's start dates or things of that nature. Again, for the most part, where our centers are located, they were not impacted for a significant period of time. We only had one center that was closed for any meaningful period of time. And again, that was a client center in Asheville, North Carolina. And within that context, it was, again, a single center.

Elizabeth Boland, CFO

Yes, back open.

Jeff Meuler, Analyst

Thank you.

Toni Kaplan, Analyst

Thanks so much. I was hoping you could give a little more quantification on the drivers within back-up care growth. If you could maybe talk about either how much is from new clients versus clients adding days to existing plans, camps, price, whatever factors you want to include just really great growth, and I just wanted to understand it a little bit better.

Elizabeth Boland, CFO

Thank you for your question, Toni. Simply put, the growth in utilization is due to more eligible employees, primarily at existing clients, rather than being driven mainly by new clients. While we do have new clients launching care, they typically see gradual adoption over a couple of years, and they don't significantly contribute to the growth in usage right away. However, by offering additional types of care and options that cater to parents' needs—such as academic tutoring, summer camp programs, or backup care during high holidays—we've been able to engage more employees at various stages of their care needs. As awareness grows, we're seeing increased usage among newer users, even as existing clients expand their utilization of services.

Toni Kaplan, Analyst

Great. And I wanted to ask about M&A. Have we started to see any more willingness from independent to sell with some of the COVID programs rolling off, just anything on the M&A pipeline and what you're seeing within the industry?

Stephen Kramer, CEO

Yes. So I mean, certainly, Toni, we continue to keep strong relationships with providers that operate high-quality programs in locations that are strategic to us. The reality is that many of those programs continue to progress enrollment and are not back to where they were in 2019, and therefore, valuation expectations at this point still are mismatched given the financial performance they enjoy today versus what they may have enjoyed back in 2019. So what I would say is we still see prospects for the future. But in the near term, we continue to be very disciplined and making sure that how we're thinking about valuation and capital allocation is reflective of our long-term strategy and not reflective of any need in the short term to be acquisitive beyond what we require.

Jeff Silber, Analyst

Thank you. I wanted to inquire about EdAssist. Although it's a relatively small part of the business, you mentioned something about muted participation growth. Can you elaborate on that? Is it a broader industry concern or more of an execution issue? If it's the latter, what steps do you think can be taken to address it?

Stephen Kramer, CEO

Yes. It's a great question, Jeff. Thank you. So look, our Ed Advisory business has two segments, right? One is supporting employee dependence through the college admissions process. We've been in that business since 2006, and I would say that, that business continues to garner clients. We continue to see improvements in participation levels. The larger part of the Ed Advisory business is what we call EdAssist. EdAssist is focused on employees who are going back to school themselves. So we manage the tuition assistance programs for employers and ultimately, like our other services are participant-driven. And so what I would say is that in the context of sort of what is market versus what is us, I would say that certainly in stronger economic times, it is fair to say that fewer people feel the incentive to go back to school, fewer people feel the need to extend their skills. So I think from a market perspective, we're starting to see a little bit of change as it relates to behavior just generally. In terms of what we're doing, I think that we are very focused on a transformation within that aspect of the business. We want to make sure that we are responding to what employers need and what their employees need in this particular area. And so we have certainly refreshed the team in that area. We are in the process of investing in the platform and the product. And then finally, we are like we did over many years in backup care, investing in the outreach and personalized marketing efforts that really do attract users. And so I would say those are the three sort of categories of things we're doing to improve our own situation within advisory, specifically within EdAssist. And this year would have been a fairly flat growth, a little bit of growth over last year. And then as we enter next year, we're hoping for slightly better than that. But again, are really focused on investing in that business for the long term.

Jeff Silber, Analyst

All right. That's really helpful. I believe we've got a presidential election in this country tomorrow. I know you really don't get much of your revenues via the federal government. But Vice President Harris had proposed a cap on external child care costs. I forget the number, but it was a relatively small percentage of total household income. I don't know if you heard anything more about this; if something like this would happen, what kind of impact could that have on your business?

Stephen Kramer, CEO

Yes. Look, I think the reality is that there has been a lot of rhetoric over many years, certainly for the lifetime of this company, having government get more involved in childcare and different regulations that they may have suggested. I think the governing factor here is financial, right? At the end of the day, to get the kind of involvement that politicians might suggest is possible requires an outsized amount of resource that government here in this country has never been prepared to invest. I would say that for sure, the U.S. government has always focused its limited resource in this area to the neediest families, which we certainly support those in most need. But the reality is that the federal government has not gotten involved more broadly in childcare. So again, this is less about which political party and more about just categorically government here in the U.S. just not prioritizing investment in early childhood education beyond those families that are most disadvantaged.

Josh Chan, Analyst

Hi. Good afternoon, Steve and Elizabeth. Thanks for taking my questions. On backup care, do you track any metrics such as the percentage of allowed days that your customers or your consumers are actually utilizing? Is there anything that you can share with us in terms of baselining where you are in terms of penetrating the total available days, I guess.

Elizabeth Boland, CFO

Yes, we monitor various component parts, but our focus has been on the overall usage because, in some ways, there's still potential to reach more individuals. Most of our client partners operate on a pay-per-use model, which includes a base fee followed by participation based on usage. This means there are no restrictions based on the number of employees or days. Offering diverse types of care at various times and in different formats allows us to increase participation without limiting individuals to their entire set of benefits. Generally, we observe that those who use the backup care benefit find it valuable and take full advantage of it. While there are some who only occasionally use it, the benefit tends to have strong engagement among regular users.

Josh Chan, Analyst

That's really helpful color. And then on the full service side, how would you characterize fall enrollment trends versus what you're expecting? Any deviations compared to what you think going into the fall enrollment season? Thanks so much.

Elizabeth Boland, CFO

As we discussed, overall enrollment for the year is in the mid-single digits, with stronger numbers in the first half compared to the second half. Generally, we anticipated the third quarter results. Our outlook remains cautious, partly due to the availability of space and the challenges in enrolling in centers that are not fully occupied. This makes it more difficult compared to the enrollment we achieved over the past several quarters. Consequently, our expectations for both the remainder of this year and into 2025 indicate continued growth in the low single digits for those centers that have not yet returned to their pre-pandemic enrollment levels.

Faiza Alwy, Analyst

Yes, hi. Thank you so much. Elizabeth, I just first wanted to clarify and confirm that there's no changes to your margin expectations by segment. I don't think you gave those for the year. I think we talked about sort of low to mid-single-digit operating margin for the full service business and maybe 25% to 30% for back-up care? Are we in a similar ballpark still?

Elizabeth Boland, CFO

Yes. I believe we experienced a minor microphone issue earlier. Regarding margins for the remainder of the year, we expect Backup margins to remain comparable to what we achieved in 2023. We anticipate an elevated margin level in Q4, exceeding 30%. For the entire year, we expect margins to be in a similar range to 2023. Full service margins are projected to improve from Q3, though they will still be in the low single digits. It's important to highlight the distribution of overhead among segments, which has impacted full service negatively by about 75 basis points this quarter, while providing a positive effect of around 175 basis points to Backup. This trend is likely to continue in Q4, but we expect to move past it as we enter 2025. Overall, we're looking at high teens to low 20s for the advising business.

Faiza Alwy, Analyst

Okay. Great. Thank you. And then hopefully, you can still hear me, but I wanted to ask about you gave some color around 2025 enrollment growth and pricing. And I'm curious if you think there's an opportunity to take additional pricing. It seems to me that the category is a little bit less elastic more broadly, but would love to hear your views on how you're thinking about your pricing strategies?

Elizabeth Boland, CFO

Yes, we are always mindful of balancing pricing with the need to deliver our service and maintain growth momentum. We are currently navigating an elevated cost structure. We have invested in wages and plan to continue being disciplined about the relationship between price and wages. However, conditions vary from center to center. Overall, our strategy acknowledges that inflation has eased somewhat, and we are considering an average price increase that is slightly lower than what we implemented this year. We have time to evaluate our options, with upcoming decisions regarding January and April price changes. That captures our current perspective.

Harold Antor, Analyst

Sorry, I was still muted. This is Harold Antor on for Stephanie Moore. Just on the U.K., I know you've been seeing improvements there. But if you could just provide us with how things are trending there employment levels there, wage inflation compared to the U.S.? And I guess, if you could give us an update on the percentage of centers that you have in the U.K. now because I know you've been closing centers with them being on the lowest cohort, just wanted to get a sense of how that’s trending? Thank you.

Elizabeth Boland, CFO

I’ll take the closure question and turn things to you, Stephen.

Stephen Kramer, CEO

I can start with the first piece, which is fair to say that the U.K. performance was largely in line with our expectations in the quarter. It was certainly a nice improvement year-on-year. We talked about the fact that 2023 was a very challenging year in the U.K. And so year-over-year, we've made some good progress. I think we had called out in 2023 that we're going to lose in the full-service business about $1,300, and we've cut that in half this year. And so we feel good about the progress that we're making in the U.K. We still progress to be made and then maybe Elizabeth will comment on the closure side.

Elizabeth Boland, CFO

Yes. So we have closed a number of centers this year. We're on track globally to close roughly 50 centers overall. And the U.K. has been certainly part of that strategy, rationalizing the portfolio there. We have identified some that are on the docket for closure in 2025. But at this point, we've closed close to 15 to 20 or so centers this year, particularly in the third quarter. But as Elizabeth said, we have some centers that we will circle it up to close here in Q4 and also in 2025 in the U.K. to optimize that portfolio.

Harold Antor, Analyst

And then I guess just on the inflation side that you're seeing in the U.K.? Would you say that it's in line with the U.S.? Or would you be pricing a little bit more aggressively in the U.K., is there anything there? Thank you.

Elizabeth Boland, CFO

So the figure that I gave was a general average around our global operations. So it will vary by both geography and there may be some parts of the U.K. where we aim a little bit higher and others where we aim lower, but that was encompassing a global view. Inflation in the U.K. has been tapering as well. I don't have right at hand the exact comparison to the U.S., but we certainly see some of the particularly acute areas like energy and food have some of that pressure that's come out of the environment. Still, services remain high, and there are a number of pressures on the labor side that we continue to balance with the tuition increases that we are considering given the challenges of the overall labor environment supply as well as wage.

Stephen Kramer, CEO

Well, thanks all very much for joining the call, and have a great evening.

Elizabeth Boland, CFO

Thanks, everyone.

Operator, Operator

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