Bright Horizons Family Solutions Inc. (BFAM) Earnings Call Transcript & Summary

Good day, everyone, and welcome to the Bright Horizons Family Solutions fireside chat. Today's call is being recorded. For opening remarks and introductions, I'd like to turn the call over to Mr. Gary Bisbee. Please go ahead, sir.

Yes. Thank you, and welcome to what is part of the Bank of America -- I should actually say virtual consumer and retail conference. I'm Gary Bisbee. I cover business and information services here at BofA Securities. I'm pleased to have the management team of Bright Horizons Family Solutions here. From the company, we have CEO, Stephen Kramer; CFO, Elizabeth Boland; and Director of Investor Relations, Michael Flanagan. I thought given what's going on in the world today, the best way to start this would just be to turn it over to the company to give some quick updates and thoughts on the coronavirus and how it may be impacting the business. And then we'll circle back and go through some questions on, arguably more important, long-term growth and other factors of the business. But Stephen, maybe I'll turn it over to you to start. Thanks.

Sure. Thank you, Gary. So first, before I sort of talk about the impact that it potentially has on the organization and our financial piece, I'll just say that, obviously, as an organization and as individuals, we are very mindful of the situation that we find ourselves in, and our hearts and minds are with those individuals that are being personally impacted at this point. What I would say from a business perspective is that at this point, we have seen no material impact as it relates to the financials of the organization. We are very, very focused on the safety and well-being of the children in our care as well as our employees. And as it relates to our center operations, what I would say is that on a typical day, we are incredibly focused on the policies, procedures and sanitation approaches that we have. And clearly, within that context, we have stepped up incrementally. But the reality for us is this is an area that we focus on a tremendous amount each and every day to keep the children and employees within our care safe and healthy. And this represents a small step-up from that. In addition to that, we have teams dedicated within each of the countries in which we operate that are focused on taking guidance and staying in front of the resources and information coming out of the CDC, the WHO as well as the local health authorities. And so we are making very proactive decisions about how to continue to keep everyone in our employ and in our centers and using our other services safe and healthy. The final piece I'll say is that it's difficult to know how this will unfold. But they're -- for those of you who know our story, it's critical to remember that the work we do is primarily employer-sponsored, and therefore, we have strong financial protections in the work that we do based on the employer contracts that we have. And so speaking of clients, we have spent a lot of time over the last few weeks, starting with me and our entire team, spending time with our clients, really understanding what their needs are, what their business decisions are. And it is very clear to us that, both in our center business as well as in our back-up business, they see us and our partnership as a critical piece of their own business continuity plans as it relates to ensuring that whether their employees are working at the workplace or at home, that they have the ability to keep those employees productive. And a key element of that for a working parent is really the idea that they're going to have care for their children. And so we are certainly being very creative with our clients about how to best serve them in these uncertain times. On the other hand, we believe that these partnerships are very durable and, ultimately, are going to be a large part of the story as it relates to our ability to withstand this. That all said, it's -- we haven't seen disruptions to date. We have no sense of being able to predict the future. On the other hand, we, at this point, believe that we will continue to operate in the way that we have successfully to date.

I think the follow-up -- we'll see how this plays out. But the question I'm getting from investors most is, just can you help us understand if you were to either proactively decide that it was necessary to shut a center or if a health department or some other authority recommended that, and you took that action, how would the economics work for your business model? My understanding is most of the full-time parents are paying monthly at the beginning of the month. And so if there was a prolonged shutdown, would -- how should we think about that plays out? Would you have the ability to reduce costs quickly? And any other thoughts on center economics in [ particular ].

Yes. So this is Elizabeth, Gary. And so yes, from a center economics standpoint, it, of course, does depend on the nature of the -- whether it's a client center or if it's a lease/consortium center. So our client centers comprise roughly 55%, 60% of the portfolio, of our capacity. So they would be insulated a bit, as Stephen just mentioned, with the arrangements that we have with clients and the partnership that we have with clients who have variably -- have either cost-plus where they are required to pay the management fee and/or they can elect to pay the tuition for their parents during the shutdown if needed or they may have the parents pay them. But they would have the obligation for the financial economics. In a center where we have the financial responsibility, as you say, we have basically a 30-day runway. Parents do pay in advance for their tuition and are required to give us 30 days' notice if they're withdrawing. And so there's a tuition-level protection for a period of time that encompasses what we certainly outlined as the separation period if we would need to be isolating from a center standpoint for some reason and have either someone who is -- we haven't had this, but if someone were infected and we needed to have a center be closed for a 2-week period of time, that would obviously be within this window. If it's a suspicion of infection, then the testing can resolve that yes or no, and the center could reopen within a few days, which would obviously be much less disruptive. From a cost standpoint, we have -- we certainly have no fixed cost in our client centers. In our lease/consortium centers, we do, but we would have the ability to be somewhat flexible on labor. We, of course, want to be taking care of our teaching staff and center staff as well. With a prolonged -- a more prolonged shutdown, we may be going to much leaner numbers of staff who are on board, able to respond quickly to either a reopening or reduced care. But I think there's some flexibility to the labor structure. And in our client centers, we feel reasonably well insulated.

And maybe a quick one, and then I'll mercifully get on to the longer-duration stuff. But in back-up, is there some potential for increased demand for the at-home portion of your offerings in this environment? And is that, today, a meaningful part of the back-up business? Or should we think that's more secondary to the center-based back-up offer?

Yes. So I can tell you that, certainly, in the last couple of weeks, we've seen very little shift in the way demand is sort of consuming itself. And so we continue to see families take advantage of in-center as well as in-home opportunities through the back-up approach. What I would say is that depending on how things unfold, it is certainly possible that we could see increased demand. Again, as I mentioned in the earlier remarks, in the same way that employers are thinking about this as business continuity, employees, as they try to figure out how they support their family as they're trying to work, back-up care represents a really good option for them. And they may choose to do that in a center, they may choose to do that at home, but nonetheless, there is the possibility that we may see the demand start to shift in one way or another depending on what the circumstances demand.

Yes. I mean even with the work-from-home environment, there could even be other center-based demand. So I think the opportunity for back-up there, again, to address the client's own business continuity needs that may have their decision -- they take a decision to have employees work from home, but the employees still need care, and they're comfortable either using a Bright Horizons center -- that employer may just have back-up care, but they could use center or in-home. So we do see it as something that we can be helpful.

Maybe we could shift to growth now. And I'd just start by saying one of the things that I've long admired about Bright Horizons has been the consistency of the strategy and how you're going about growing the business and, obviously, the execution as well, which has allowed the company to compound earnings at double-digit rates for, I guess, close to 20 years now through 2 stints as a public company. At a high level, and I'll dig into this in a few more questions later, but how are you feeling about the opportunity in front of you, obviously, aside from any short-term coronavirus impact, to continue to deliver double-digit annual profit growth from your business?

Yes. So I think that, first, I'll start with top line, which is we continue to see good opportunity to grow the business through organic growth. And our reality is that employers continue to be interested in investing in the kinds of services that we offer given the war for talent now, given the idea in their mind that we are a key part of their business continuity programs. So again, I think that within the universe of those who do not currently partner with us, we see really good opportunity continuing to persist on employer-sponsored child care as well as on our back-up and ed advisory businesses. One of the things that we've highlighted over time is the opportunity that we see on the cross-sell side. So this past quarter, we hit a milestone of 25% of our clients now buying more than one service. We've put a lot of energy around helping our teams to get more aligned to get better incented around cross-selling. And I think it is paying dividends as is exhibited from that statistic. And so we see a lot of room for growth as it relates to adding additional services to the services that a particular employer may offer. And then ultimately, we see our ability as we grow to continue to lever the cost structure. And so we have a long history of being able to grow margins at, call it, 50 to 100 basis points. And we see that as something that we can continue to persist in light of the top line growth. And so very directly, Gary, I think we have an algorithm that is well proven that we will continue to persist with that will see us growing top line, will continue to see us get operating leverage and then ultimately will result in some really strong contribution leverage.

Great. And so if I could dig into the full-service center business. You grow that business through both organic new openings and through bolt-on and sometimes larger acquisitions. If we just look at the organic openings, the number you open has been surprisingly consistent over the last decade, and yet the total center count is up nearly 50%. It implies somewhat slower unit growth, at least organically, than you had 5 or 10 years ago. And I guess if the demand is so strong, what's the gating factor to maybe accelerating the number of openings that you're doing? Or is it more just about your capacity to win those and deliver those?

Yes. So what I would say is on the employer side, obviously, the gating factor there is getting the yes with the employer clients, interest in first having an on-site child care center, finding available space and then ultimately investing the capital. And we continue to be focused on that opportunity, and we have an unlimited appetite. And so the gate really is convincing employers to either have their first center or open additional centers with us. The other piece that's within that is those who have existing centers, typically in health care higher ed where they may self-operate, convincing them to turn over the management of those to us. So I think that's sort of category one. I would say on the lease/consortium side, it's really down to being disciplined in identifying strong locations that come at a rent that is affordable to us given our model. And so you take New York City as an example, we focus on the streets, not the avenues, and we need to be on the first floor, and there are a number of requirements. And so as we have unfolded our urban strategy, real estate is often the rate-limiting step. But we are also mindful of making sure that we're lining up employer support and, at the same time, making sure that we have the operational capacity within a particular geography to continue to stage those openings. And then the final piece on the acquisition front, acquisitions have always been lumpy in our history and will continue to be, just based on the willingness of a seller to sell and when that is. So we believe that we're an acquirer of choice in our market. Individuals who are selling their child care centers really look at the legacy that they're looking to have, and having it sold to Bright Horizons, they believe and we believe, will continue to propagate a great legacy for them as owners. And so it's really about whether or not the time is right for them. The comment I would make is that coming out of the 2008 downturn and maybe the case in the current circumstances, we did see an opportunity and an uptick for us to invest more capital in acquisitions. When owners had gone through a more challenging period, they were more open-minded about their willingness to sell. And so the possibility certainly exists once we get past this challenge in the environment that there may be more programs that are of quality in strategic locations that have financial profiles associated with what we look for that may come available.

All right. That's a great summary. If I could ask a few questions about the lease/consortium center model and strategy. That, I'd still say, is probably the thing I get the most questions about from investors over time. And it's been a key strategy for 7 years. You've seen good growth. I think it's now right around 10% of center-based revenue. And yet we've seen, as the base has matured and several classes have become profitable, that the strategy in total remains, if I understand it correctly, well below your segment average profitability. What is the pathway to getting that business up to more attractive margins? And should we think it's just slow and steady march as you each year have another class that's reached that maturity level? Or is there a potential for that to happen more quickly as we think about the next couple of years?

Yes. I'll take that, Gary. The -- I think the headline answer to that is that we would likely expect it to be more of a steady march of improvement because of the combination of a couple of factors. One is the fact that we continue to open new classes of these centers that are adding into this mix of around 100 now that, as you say, have rough magnitude is $175 million or so of revenue and generating around 10% margin compared to north of 20% in the overall full-service business, that there's -- the positive runway there to get those not only the revenue higher but the margin up to 20% is where we really see the value-creation opportunity. And getting there involves continuing to eke out additional enrollment where we can in the oldest classes and in getting those that have had a longer slope to maturity. And the examples that I use are typically tied to or related to a development area that has had more protracted construction than is ideal for parents to be enrolling in the center. So that's been Hudson Yards, which we've talked about in the New York City area, but it's also true of the Seattle market, which is very fertile from the standpoint of the working professionals, the numbers of employers that are there. And the lease zone opportunity is really strong in Seattle, but it's also a big construction zone, just the whole greater area there in -- I hate to say it, it's really not just Seattle, there's a number of cities that people like to associate with. But it is certainly an area that has opportunity that needs to get through the time of disruption when buildings are going up, and it's more challenging for parents to get there. So that would be sort of a countervailing impact on the opportunity of a number of these centers that we've talked about that it opened back in the 13, 14, 15 area, which are -- they're generating $2.5 million to $3.5 million of revenue. They're generating 20% to 25% gross margins. And so the dollars that they're converting are substantially higher than the rest of the installed base. And they're serving working families that are working for either smaller employers or who may be working for our existing employers but not at a headquarters location. So we're serving them in a different kind of a facility. And I think the last point I'd make is that we're also able to augment that with back-up care as these centers can also be part of our supply chain for delivering back-up against that ever-broadening population of clients that we serve. So I think that we've -- what we would say, if we look back 7 years, is that -- of course, you model everything to ramp up in 3 to 4 years. And we have some centers that have followed that trajectory, some that have ramped up faster and a few that have taken longer. But across the portfolio, we've got a well-performing group that has more upside to come. And it's just taken a bit longer than maybe it would have been modeled out or penciled out on paper, but the opportunity persists.

And I guess the follow-up on that is just, how important is the strategy to the sort of -- to -- for adding capacity to back-up? And is this, sort of a strategic imperative, we need to open more of these because of the very strong growth in back-up? I realize you expect them to be stand-alone, quite profitable on their own. But is that a key part of the strategy?

So I think it certainly plays into where we ultimately locate these. But again, because our strategy is so aligned where more and more of our employer clients are in and around the urban area and we're opening these centers in the urban area, we're seeing that, certainly, the 2 are very well connected. But as you rightly note, we are opening these with the expectation that on a stand-alone basis, these can be successful. But certainly, over time, they'll even be better because of their access to back-up care.

Fair enough. And maybe that's a good transition to back-up. 2019 was an exceptionally strong year for the business, aided in part by a strategic bolt-on but also very good underlying acceleration in organic revenue. What were the key factors there? And I think it's clear part of it was the series of technology investments you made a couple of years ago. But -- and would you attribute most of it to that? Or are there some other drivers of what's been quite strong performance?

Yes. So first, you were right to sort of indicate that we did have an acquisition in 2019 of My Family Care in the U.K. that was our largest competitor in that marketplace that we came together with that, again, had stimulus to the growth rate in the business overall. That said, we had a very good organic growth here as well. What I would say is that it's down to a couple of key factors. The first is that in terms of our clients and prospects adopting back-up, what I would say is we had a very strong sales year and ultimately brought on a number of new clients that allowed for some of that growth to be realized. The second and probably more significant factor was the growth of our existing accounts. And we believe in and have talked a lot about the technology investments that we've made in that line of service to make the experience more seamless for the end user as well as to have better and more personalized digital outreach to the end users. And what I would say simply is that it's working. So we had an increase in terms of the number of reservations and the number of reservations that were happening through our mobile app, that were happening on an instant book basis, where the confirmation of care is happening on an immediate basis, again, all things that are making the usability of this service better and better over time and, therefore, causing and stimulating more use and more reuse. The second is, on the personalized outreach side, I think we have continued to refine our ability to execute on marketing journeys that are very personalized to the end user and are having real response rates that are different from what our historical response rates have been, and ultimately, that is causing increased use as well. So with a business like back-up, which underlying economics are driven by use, the idea that we have created a better experience and ultimately provided outreach that stimulates additional use, that has been very positive for the business.

And given that a lot of that comes from those technology investments of 2017, I think it was, if I remember, is -- I'm sure investment has been incremental since then. But are there opportunities for another step-up? Or do you think you're really in the right place today from a technology perspective?

Yes. I'd say that we feel good about -- you're right. It's modestly increasing year-over-year proportionate to the rest of our growth, and we see that as an ongoing appropriate investment. I wouldn't say that we see a significant step-up like we had talked about in '17 affecting -- having a call-out to the margin. But we do see this as something that is an ongoing spend. If nothing else, there's more expectation for more functionality always coming down the pike. And then there's also just the refinements and improvements to our initial version 1, version 2 that we can continue to get better.

And Stephen, earlier, you commented on the success you've had with cross-sell and 1/4 of your clients now buying more than one. What have been the keys to that? And is there anything about the clients that have done that, that help you think through like what ultimately the opportunity is? Is it only the very largest clients? Or do you think you have potential to continue to drive that rate higher in the next several years?

Yes. So first, I think we will continue to drive that higher over the coming years. I think the first thing is that I think we aligned ourselves much more effectively in terms of our sales and account management teams. When we were a single service selling only child care centers here in the U.S., it was appropriate to have our sales team focused on selling new logos and our account management team focused on managing those accounts. But over time, as we've had more services being introduced in the marketplace, now back-up care and ed advisory, we really have reconfigured the team such that the sales team now is going after new logos, certainly, but at the same time is spending time continuing to cross-sell into our existing clients. And so first, I think the rules of the road and who we have facing off with our clients has evolved and how that's aligned has evolved. I think the second is that we certainly have gotten incentive systems aligned. So now we are compensating our salespeople and our account managers on the ability to have clients buy more than one service. Underpinning all of this has been the rebranding effort that we undertook this past year where part of our challenge was that people didn't realize that BUCA and EdAssist were part of the Bright Horizons family. And so they really didn't think of us as a child care center company. And I think we've done a lot to educate, through our brand, now everything being affiliated with the core Bright Horizons brand, allowing that to hang better together. I think from an operational standpoint, we've also done a lot to begin to tie the services together to give someone -- to give an employer a reason why there is more value in the whole than any of the pieces individually. And so we've done a lot with consolidated login for end users, consolidated reporting and things that will just make us a better partner to employers and their employees. And then I'd say the final piece that we have done is we have stratified our clients, exactly as you described, to focus on -- focus our resources on those accounts that have the highest potential and the highest potential to cross-sell based on ones that already have. And so I think we've been really thoughtful about where to focus our energy, and I think it's making a big difference.

That sounds great. One other thing I noticed as I think back over the last year of conference calls and dialogue is there's been more discussion of potential for international expansion into new markets. I think on the last call, you even called out a handful of markets that you saw as potentially attractive or, at least, supporting your business model and price point with support from corporate or government customers. What should we read into that? Is this discussion signaling any increase in the desire to enter additional markets at this point? Or was it just sort of the natural evolution of how you've talked about expanding?

Yes. So to be really candid, Gary, I think the reason we talk about it more is because we get asked more about it rather than it being necessarily something that we feel is really a strategic shift from where we've been. So certainly, we see a tremendous amount of opportunity in the U.S., the U.K. and the Netherlands. Each are growing really well across our service lines, centers, back-up care and ed advisory, again, growing really well. So unlike different companies who feel pressure to grow into new markets because they're seeing the opportunity dry up in their home markets or in their core services, that is certainly not the case for us. On the other hand, we continue to be really mindful of opportunities that exist across the globe. And if you think about, first, the fact that we are very selective about the countries that we enter, they have to have some form of third-party support, whether that be employer and/or government. And then the second piece is that we typically spend a lot of time making sure that we're finding a like-minded partner in a particular geography. So again, in terms of getting over our skis around this topic, we will continue to be incredibly thoughtful about any international expansion beyond where we are. But on the other hand, we are in this for the long term and continue to build really valuable relationships with organizations across the world.

Right. And you also have made acquisitions in the 2 -- in your 2 other segments in the last 12 or 18 months, which was not something we had seen much of historically. Is that just you found -- opportunistically found some good opportunities? Or is there a strategy to expand those? And part of the reason I ask that question is, while they have grown faster -- much faster on an organic basis than the full-service centers business, when I look at the mix, actually, of revenue or profits, it hasn't moved a lot. And I think that's -- the reason is you've done more M&A in the last 5 to 10 years, obviously, in the center-based business. But are there more opportunities? And how do we think about M&A in your smaller segments?

Yes. So I think we've been very fortunate with the acquisitions that we've made over the last few years in our emerging services. So buying our largest competitor in the U.K., buying a competitor here in the U.S. in our ed advisory business, those were very strategic acquisitions for us. I have to say that part -- so absolutely, that is on strategy, and again, to the extent that they exist, we will continue to do those. What I would say is I think that, in most cases, what we're finding is that as we continue to create distance between us and the next largest competitor in our markets and really expand our market leadership in those markets, the competitors are finding it increasingly difficult to have the kinds of capabilities that we have and ultimately are finding it difficult to win in the marketplace against us given the demands of our employer clients. And so ultimately, what's really exciting about those emerging services is that like in our core business of employer-sponsored child care, we continue to distance ourselves from our next largest competitors and continue to show our market leadership in each of the areas in which we compete.

And then this obviously assumes no impact from coronavirus, but one of the real gems of the business model over time and the ability to drive margins has been the ability to earn price increases that have modestly exceeded your labor cost inflation. Is that something that you have -- confidence continues? And if we were to have a weaker economic period, whether coronavirus-driven or some other reason, how's the confidence in the ability to continue to deliver pricing at the level you've done?

Yes. I mean, look, I think that, first and foremost, we have a really long history of being able to price ahead of wage increases, recognizing that wage increases, while it's a large part of our cost structure, is not the only cost escalator that we absorb. And so we have a long history. And the question really becomes that if there were a downturn, and we've seen this, obviously, it may be that the pricing is no longer in sort of the 3 to 4, maybe it's in the 2 to 3, but wages would then follow, right? So typically, what we have seen is that they'd move in concert, and we obviously project that and allow for that to be the case. But we find that in times where pricing is a little bit more modest and a little bit less sort of exuberant, then we get into a scenario where, likewise, on the labor side, wage inflation is less as well.

Okay. And I think we have time for one more question, and I'll let you go. But -- and maybe this one for Elizabeth. When I look at the cash flow and the capital allocation since the IPO, it's interesting that leverage has come down pretty consistently but really stepped down in the last year to what's now 2.6x, roughly. And yet buybacks were the lowest annual amount since the IPO as well. Given rates where they are and everything else, I guess why the deceleration of buybacks? Or how are you thinking about that decision to be less aggressive there? Is it rising valuation? Is liquidity an issue? I know historically, the easiest thing was blocks from Bain, but they're no longer involved. I guess, any other thoughts on that?

Yes. So I think that the dynamics are -- have some interplay there. Of course, Bain coming to market with blocks offered an opportunity for us to participate in a more meaningful way versus -- we've reasonably good liquidity now still on the lower end maybe for the size of the market cap of the company. But I think from an opportunity standpoint, that's where the bigger volume of opportunities were, and we obviously have some very well-priced debt and have been able to do a bit of leverage behind that to affect those share buybacks when they came to market. Since then, I think we've been -- it's in a -- again, in an environment where we are balancing off -- last year, we had -- still had $100 million outstanding on the revolver prior to the year. We're paying that down. We continue to look for the acquisitions we've been talking about earlier on this call. And that's -- between that and new lease/consortium centers, that's our primary investment desire. And so buybacks have been third on the list. And I think you'll see us continue to participate there. We have been participants, and we will continue to be. And certainly, where the stock is now, it's even a more opportune time. But we've got, I think, a very steady and stable capital allocation strategy that we've tried to combine what we see coming down the line, both with our own internally controlled growth and then the external factor, which is when acquisitions come to market are available, sellers are ready to go and they fit our criteria. And today, we've been able to jump on those and want to -- always want that to be something we can do with speed. And so it's really just a balancing out of those different options. Nothing else to add there.

Great. Okay. Well, I think we'll leave it there. Thank you all for your participation, and thanks, everybody, for dialing in to listen.

Yes. Thanks, Gary.

Thanks, Gary.

Thanks, everyone.

That does conclude today's conference. We thank everyone again for their participation.