Bright Horizons Family Solutions Inc. (BFAM) CEO Stephen Kramer on Q3 2022 Results – Earnings Call Transcript

Bright Horizons Family Solutions Inc. (NYSE:BFAM) Q3 2022 Earnings Conference Call November 1, 2022 5:00 PM ET

Company Participants

Michael Flanagan – Senior Director of Investor Relations

Stephen Kramer – Chief Executive Officer

Elizabeth Boland – Chief Financial Officer

Conference Call Participants

George Tong – Goldman Sachs

Andrew Steinerman – JPMorgan

Manav Patnaik – Barclays

Jeff Silber – BMO Capital Markets

Toni Kaplan – Morgan Stanley

Faiza Alwy – Deutsche Bank

Jeff Miller – Baird

Operator

Greetings, and welcome to Bright Horizons Family Solutions Third Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

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

Michael Flanagan

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

As a reminder to participants, any forward-looking statements made on this call, including those regarding future business and financial performance, including the impact of acquisitions in COVID-19 on our operations are subject to safe harbor statement included in our earnings release.

Forward-looking statements inherently involve risks and uncertainties that may cause actual operating and financial results to differ materially and are described in detail in our 2021 Form 10-K and other SEC filings. Any forward-looking statements speaks only as of the date on which is made, and we undertake no obligation to update any forward-looking statements. We may also refer today to non-GAAP financial measures, which are detailed and reconciled to the GAAP counterparts in our earnings release, which is available under the IR section of our website.

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

Stephen Kramer

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

First, to recap the headline numbers for the third quarter. Revenue in the quarter increased 17% to $540 million with adjusted net income of $38 million and adjusted EPS of $0.66.

In our full service childcare segment, revenue increased 14% in the third quarter to $381 million. We added four new centers including one for our new client QuikTrip, and we completed the acquisition of 75 centers in Australia. We also reopened four of our temporarily closed centers in Q3 and in the quarter with 99% of our 1,081 centers open.

Across our portfolio of light for life centers, we saw mid single digit year-over-year enrollment growth in Q3. In the U.S. our centers located in the largest metro areas continue to progress their enrollment recovery with New York City, San Francisco in the Bay Area, Los Angeles and Atlanta showing notably strong year-over-year enrollment gains.

Our higher ed, healthcare and industrial clients that represent approximately 60% of our clients and portfolio continue to show the highest occupancy levels, while our tech and consumer clients centers experienced the fastest enrollment growth over the prior year.

In terms of age mix infant and toddler enrollment grew 8% over the prior year, more than double the rate of our preschool despite the more acute staffing challenges in these younger age classrooms due to tighter titled teacher to child ratios.

While staffing continues to constrain enrollments in most geographies, we saw incremental progress on the retention and recruiting from this past quarter. Our recent investments in teacher compensation have had an impact on retention, and we continue to see greater the interest from job seekers. Taken together this has resulted in continued improvement in net hiring.

Importantly, the gains made in overall staffing levels is enabling center directors to spend less time covering classroom hours and more time on traditional leadership activities, including engaging with prospective families through tourism visits.

These marketing activities, which had been severely curtailed during the pandemic, are helping us rebuild the enrollment pipeline to drive all classrooms back towards pre-pandemic occupancy levels.

Outside the U.S. enrollment trends remains and the UK and the Netherlands, growth was muted as labor market challenges continue to restrict our ability to serve all of the enrollment demand that we have. We have several initiatives underway to drive recruitment in the face of a market that remains very challenging in the availability of qualified classroom staff.

In addition to stalling of our enrollment growth, the other short term impact of this is higher labor costs given a greater reliance on agency staff to augment directly employed teachers, which comes at a cost premium.

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

Let me now turn to back-up care, which delivers exceptional results this quarter. Revenue increased 30% over the prior year to $129 million, outpacing expectations on strong use in the third quarter.

We also continue to see good new client success with Q3 launches for Hard Rock International, Leader Corporation, Lucid Group and Premier Health Partners to name a few.

As we spoke about last quarter, we were encouraged to see record use in June with that momentum continuing throughout the third quarter. We saw use across all of our care types, resulting in our highest revenue quarter in our backup segment history.

A particular note was the contribution of Steven and his team in acquisition that we made in 2021. Under our ownership, we expanded their footprint enabling us to increase our available backup capacity and serve a growing number of families with school aged children.

Additionally, as part of our broader strategy to expand the utility of backup here to a broader set of eligible client employees, we recently rolled out pet care as an additional use case. This follows the successful pilot with a third-party service provider over the last several months.

Along with virtual tutoring and expanded school aged camp program, this is the latest example of our product innovation designed to drive greater adoption and frequency of use.

Moving on to our education advisory business, which delivered revenue growth of 14% to $31 million. We added several new clients in the quarter, including launches with AmerisourceBergen, Johns Hopkins and VMware.

We continue to see solid use levels, with particularly notable participant growth assists in the quarter. I continue to be excited about our opportunity and workforce education, as this remains an area of focus for employers looking to differentiate their employee value proposition and upskill employees into harvest different roles.

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

Before wrapping up, I want to take this opportunity to reflect on the signature employee recognition events that have been occurring across Bright Horizons over the last couple of months.

This year, we had nearly 25,000 award nominations from clients, families and colleagues. And after two years of booming virtual celebrations, it was great to celebrate with colleagues here in [Indiscernible] two weeks ago. My heartfelt appreciation goes out to all of our employees who work tirelessly each day to make a difference in the lives of children, families, learners and workplaces.

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

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

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

Elizabeth Boland

Thanks, Steven. Hello, everybody, and thanks for joining us tonight. I’ll recap the quarter results and then provide some updated thoughts on the remainder of the year as well.

For the third quarter overall revenue increased 17% to $540 million. Adjusted operating income held steady at $46 million or 8% of revenue, while adjusted EBITDA of $81 million or 15% of revenue increased 2% over the prior year.

In third quarter, we added 79 new centers, reopened four centers that have been temporarily closed and permanently closed 12 centers, thereby ending the quarter when 1,081 centers.

Our full service revenue increased $47 million to $381 million in Q3 or 14% over the prior year. Revenue gains were driven by increased enrollment in pricing, which contributed approximately 10% to revenue expansion, as well as by the addition of Only About Children, which we acquired effective July 1, and which contributed 37 million in the quarter.

Enrollment in our centers open for more than one year increase mid single digits with 5% enrollment growth in the U.S. and our European operations were narrowly positive less than 1%, reflecting the effects of having to limit enrollment due to constrained availability of staff.

Our occupancy levels average 65% to 60% in Q3 as the typical preschool enrollment seasonality over the summer months, results in lower occupancy sequentially from Q2 to Q3. Two notable factors were 7% headwinds to this growth.

First, the strengthening dollar resulted in a $19 million year-over-year headwinds in Q3. And second, outlook support for childcare services, support we’ve received on clients behalf, reduce client subsidy revenue by $10 million, which was an incremental $6 million compared to the prior year.

Adjusted operating income for the full service segment contracted $13 million to a loss of $3 million in Q3. The third quarter is historically our weakest quarter from an operating income standpoint, mainly driven by the preschool enrollment seasonality over the summer months.

As we’ve seen throughout the year, ARPA government funding directly to the childcare sector continues to provide support to the inefficient cost structure during this ramping period. We received $14 million of this support in Q3, up slightly from the $12 million we received last year.

Looking at the components of operating income, in its most recent quarter, it was impacted by higher labor costs, including investments in teacher compensation, which were effective mid quarter and outside spend on agency staffing internationally.

In addition, as center directors recovering fewer staff vacancies, as has been the case over the last two years, they’ve been able to pivot back to leading center operations and enrollment initiatives. This is a key driver to rebuilding the enrollment pipeline and converting new enrollments for the future.

Back-up care revenue growth increased 30% in third quarter with total revenue of $129 million. As Steven mentioned, we’re particularly pleased with the strength of use growth through the quarter and resulting operating performance, which deliver $40 million of operating income or 31% of revenue in the quarter.

Our educational advising segment delivered growth of 14% on contributions from new client launches, the expanded use and head assist, college admissions and financing advising and in our Sittercity services.

As we’ve spoken about in the past, education advisory is at an earlier growth stage and the associated innovation figured out the required investments to execute against a growing and evolving market opportunity.

This can result in variability in the operating performance for each quarter as a business, and the businesses invest and grow and scale. Illustrating this, while additional investments in technology and customer acquisition within these businesses dampened operating profits earlier this year, its most recent quarter reflects solid operating profit growth and margins of 27%.

Turning now to few other earnings factors. Reported interest expense was $12 million in Q3 including $1.5 million related to the accreting interest on the $106 million deferred payments for Only About Children, which is payable at the end of 2023.

Excluding this amount, which is added back in the non-GAAP adjustments, we expect interest rates to tick up to around $12 million plus in Q4 given the current rate environment.

The structural tax rate on adjusted net income has also increased to 27% for 2022, compared to 22% in Q3 of 2021 on increasing taxable income, and lower tax benefits from equity activity under ASU 2016-09.

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

Moving on to our outlook for the rest of 2022. Our updated guidance reflects the current operating trends and performance and includes more significant foreign exchange headwinds, higher interest expense and higher tax rate expectations than previously estimated, as well as the continued inflationary pressures that we’ve been seeing with labor, energy and food costs.

In terms of top line, we expect 2022 revenue of $2 billion, which includes approximately $16 million year-over-year headwind for foreign exchange. This is approximately $15 million higher than we had previously estimated.

At a segment level, we are expecting full service to grow roughly 15%, back-up care to grow in the range of 15% to 18%, and ed advisory to increase between 7% and 12%.

In terms of earnings, this will translate into adjusted EPS in the range of $2.60 to $2.65 for the full year 2022. This narrower range includes our updated estimate of the higher tax rate that I mentioned, 27%.

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

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question and answer session. [Operator Instructions] Our first question comes from George Tong with Goldman Sachs. Please proceed with your questions.

George Tong

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

Elizabeth Boland

So, the foreign exchange is the main change. I think that you’re seeing, George, in Q4. Sequentially, we do have backups in its high watermark in Q3. So there’s a little bit of a pullback that we would see in backup during the 15% to 18% range that we’ve provided there. But those are really the only factors. I don’t know that it’s a downgrade in our view, it’s really same range that we have provided with the updated FX.

George Tong

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

Elizabeth Boland

Yes. So, I think I commented on that in the P&L centers, we had $14 million coming through, that was a cost offset that in our cost plus type client centers where we have an offset to the revenue that was around $10 million. And so that’s, again, because it reduces the cost in a client center that reduces the amount of subsidy that a client needs to pay us. So it has that effect of it, but its not really accruing to us, it accrues to the benefit of a client. So we think of the P&L impact, it’s $14 million and so that’s the P&L effect. For the rest of the year we would be expecting that to correlate that 14 and we sell this quarter to perhaps another 5 to 10 for the rest of the year. And from a client standpoint, it would be — it’s probably for $4 million or $5 million or so that they offset client revenue, but somewhat similar proportion to what we saw in Q3.

George Tong

Got it. Very helpful. Thank you.

Elizabeth Boland

Thank you.

Stephen Kramer

Thanks George.

Operator

Thank you. Our next question is from Andrew Steinerman with JPMorgan. Please go ahead.

Andrew Steinerman

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

Elizabeth Boland

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

Stephen Kramer

Yes. The FX was $90 million both in full service around 6%. The client ARPA that we received, the ARPA that we have clients was another kind of 300 basis points or so. So, no more organic constant currency within full service was around 10% growth year-on-year.

Andrew Steinerman

Did you say 10? I didn’t hear you?

Stephen Kramer

10. Yes. Full service grew about 10% constant currency organic.

Andrew Steinerman

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

Stephen Kramer

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

Elizabeth Boland

We would fill that out, Andrew, but it’s probably close to that 8% to 10%.

Andrew Steinerman

Okay, I appreciate it. Thank you very much.

Operator

Thank you. Our next question comes from Manav Patnaik with Barclays. Please proceed with your question.

Manav Patnaik

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

Stephen Kramer

So, if you don’t mind just repeat the question, you are a little bit muffled?

Manav Patnaik

Yes sir.

Elizabeth Boland

Was it about client distribution [ph]?

Manav Patnaik

Yes. Just what the client, you did a bunch of different carve outs and infant goals and preschool goals. And without having a base to it, I was just hoping to pull through it out for us in terms of what you’re hearing, really hearing from your clients in terms of the quarterly cadence of occupancy?

Stephen Kramer

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

And then the question was about clients, and clients sentiment Manav, which I believe was the second part of your question. We continue to have really positive sentiment from our existing client base around the centers and the importance of those centers to their employees and specifically to some of their return to office clients. In addition to that, certainly we have seen a very strong pipeline as it relates to prospective clients being interested in investing in childcare very specifically, looking at new centers, as well as clients or prospective clients who may self operate their own centers in the form of healthcare or higher ed, who have historically many of them have self operated, being interested in the potential of transitioning those centers of management. And so I think in all of those cases, we are very well-positioned to continue to partner with clients on this really important topic to them and to their employees.

Manav Patnaik

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

Elizabeth Boland

Yes, I mean the performance with the full service this quarter was, as I talked about, constrained by a number of the labor impacts. And so we would expect those to be continuing in the fourth quarter to some degree. So the full service segment performance should be close to breakeven around that range, and perhaps, plus minus, but close to that similar, hopefully a bit improved. But that’s around where we are this quarter. So we would expect that to be similar, a little bit of uptick in enrollment through the rest of the year, but modest. And back-up performance, as you might know, from the history of the way that back-up performs sequentially, or just overall for the year.

We have a high watermark in terms of revenue and had solid margins this quarter. Our long term view on back-up would be 25% to 30% operating margins, but in Q4 it often is a bit higher. And so, given the way that utilization gets consumed, people have banks of use that they can use it or lose it and so there tends to be some opportunity there with our clients and so we would look to margins to be closer to 35 maybe high as 40% in Q4, and then the Ed advising business is fairly steady. As we’ve said 25%t o 30% is where we delivered this quarter. So, could be for the higher end of that in Q4 as well.

Manav Patnaik

Thank you.

Operator

Thank you. Our next question is from Jeff Silber with BMO Capital Markets. Please proceed with your question.

Jeff Silber

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

Elizabeth Boland

So yes, I did. The overall averages is 55% to 60%. As we sort of came through the seasonality we would expect it to be lifting up a couple of percentage points on average for the rest of the year. And so that’s a little bit of uptick. Now that we’re through the fall cycling, and we’re enrollments but the bigger lifts would be early in 2023, as we get into that, more of a high watermark is Q1, Q2.

Jeff Silber

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

Elizabeth Boland

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

Just setting that previous commentary to one side for a second, we have a target enrollment level that we consider mature centers to get the AME [ph] or 70% to 80% has been where we operated. And that’s where we are targeting to get back to, if you will, from post COVID recovery. And so if we look at that 70% to 80% range, we actually have 25% of our portfolio is operating in the third quarter. They are operating at around 80%. So we have good really strong performers sightlines on a quarter of the portfolio is very well performing, not all the way back in terms of a margin deliveries, but the margin as a percentage of revenue, even though the uses is back, the enrollment is strong. And we have one more cycle, probably a price to cost ratio to get back to our pre-COVID margin there, but very close on that piece.

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

Stephen Kramer

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

Jeff Silber

Okay, appreciate the color. Thank you.

Elizabeth Boland

Thanks.

Operator

Thank you. Our next question is from Toni Kaplan with Morgan Stanley. Please proceed with your question.

Toni Kaplan

Thanks so much. I wanted to ask another question about the government subsidies. I believe the number of the large programs liquidity in 2023. So just wanted to help understand the expectations of what this means for 2023 year-over-year? And maybe what a normal year for government subsidies are like maybe pre-COVID? Thanks.

Elizabeth Boland

Sure. Thanks Toni So just to recap where we are this year, we are expecting essentially positive income statement effects, if you will, around $50 million to $60 million for government funding. It’s primarily ARPA funding that we are now in the midst of receiving and that ARPA funding, as you suggest is sunsetting in September of 2023, based on the current status of the regulation. So states still have money to distribute, quite considerable funds to distribute, but based on our sightlines, on what we have, where our footprint is, and where we have applied for support there, we expect that 2023 could be half of that. And to be on whether that is better, but it’s up to the states to decide. So certainly, we are looking ahead to a reduction in the amount of support that we’ve been able to receive this year looking ahead to 2023. Prior to COVID, we were not — we have a very small footprint of families who are receiving support through various government programs. And so, while it may be 0.5% or 1% of our revenue and a pre-COVID environment that we have such support in the U.S.

Of course, in our international operations, it is a international programs. And so families access the support for the three to five year olds in the UK and for all families in the Netherlands and Australia. So those support systems are just eligible for working adults and working parents. And so those in terms of their support factor, it’s really built into the intuition structure.

Toni Kaplan

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

Elizabeth Boland

Yes, it’s actually a seasonal changes. The sequential decline is quite consistent with where we’ve seen. There is growth over last year. So a year-over-year increase. The sequential change from Q2 to Q3 is based on the preschooler cycling out into elementary school. And so, that’s why we cited the again in enrollment is higher in our infant and toddler groups and a little bit lower in the preschool group because that’s a net gain in preschoolers is about half 3%, 4% whereas infants and toddler growth is more like 7%, 8% averaging out to around that mid single digit. So the change from 55% to 65% on average is simply that sequential seasonality and it’s not weakness, per se from staffing.

I think our staffing challenges are constrained to growth from being more than that. And so that’s where we have been talking about our investments in the wage construct, benefits construct in order to attract staff and really take advantage of the demand that we have to move that group of senators that wasn’t in the strongest performing group that I mentioned, that is in 80% enrolled, or the weaker performing group that’s under 40% enrolled. So to get that 40% to 70% group, if you will, up to its target. That’s where we have a real opportunity.

Toni Kaplan

Super. Very helpful. Thanks.

Elizabeth Boland

Thanks.

Operator

[Operator Instructions] Our next question comes from Faiza Alwy with Deutsche Bank. Please proceed with your question.

Faiza Alwy

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

Elizabeth Boland

Sure, I’m happy to start and Steven can weigh in as well. So, as we look ahead to 2023 we are in the throes of our planning process for that. And we will, of course, have more specific information to provide when we talk to you all next. But as we look at the events closing out 2022, we have been making progress. As we said, on the enrollment front, we’ve invested in our recruiting efforts, our teacher attraction, retention, marketing, we’re investing in wages, et cetera. So we would expect pricing increases in our full service business, certainly to see pricing increases above our historical average.

So certainly, we haven’t finalized this, but certainly would be looking to ranges in the mid to higher single digits, so 5% to 7% knowing that we need to remain competitive, and we’re in a marketplace that we are certainly aiming to get enrollment back as well as maintain the pricing that we believe are appropriate for the service for delivering. So pricing is around that. We would expect wage inflation to be ammoniating some maybe reverting to a more typical range of around 3% to 4%. Although wage will be higher than that, because we did make a substantial investment in compensation this summer and fall. And so the knock-on effect of that would be that the labor costs will likely be in the more the high single digits to 8% to 10% likely, overall, because of that knock-on effect coupled with a more modest wage inflation.

Other inflationary costs are coming through things like energy and some other consumer goods that we have, although those are smaller portions of our overall cost structure. From our backup business standpoint, this year we are looking at growth in the mid to higher double digits 15% to 18%. That has been — its been a very strong year. We’re coming off of coming COVID lapping year tax. We have good strong client accounts that we can continue to build on. And so we would expect that to grow in the double digits, but probably more like low to mid single digits. That again, we will refine as the year goes on. But that’s what we’re looking at probably from the back-up business standpoint. And that’s probably the array of Bright gross metrics of how we’re looking at next year. But any thoughts on that sort of client perspective?

Stephen Kramer

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

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

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

Faiza Alwy

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

Stephen Kramer

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

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

Faiza Alwy

Great. Thank you. If I may just ask one more quickly on just the margins on educational advisory. I know you’d made some tech investments earlier in the year. Are you past those investments? Because I see a pretty big increase in margins this quarter like is this, I know that your long term is 25% to 30% margins? Are we sort of past the investments and is this sort of the new run rate?

Elizabeth Boland

That’s in a range of what our long term expectation of that segment would be. And we recited 20 to 30, as I know, that’s a wide range, but we recited 20 to 30 as range for a technology backbone, less labor intensive, technology delivered service. But I think it’s fair to say that in a more emergent type of segment like the ed advising businesses all are, there are periodic and episodic investments that need to be made. So I would say that the investments are in the rearview mirror, just that the earlier part of the year between some technology, some enhanced, the build out of some of the elements of the Sittercity, marketplace, the ongoing investment in our EdAssist business, which is both doing advising for adult learners and administrative processing of the college work. It is an ongoing investment and I think keeping up with the developments in innovation in that sector will require ongoing investment. So I think we were just trying to point out why it might be lumpy. A couple of quarters may have some investments and then you may see either the short term payoff or a longer term payoff strategy.

Faiza Alwy

Got it. Thank you so much. Really appreciate it.

Elizabeth Boland

You are welcome.

Operator

Thank you. Our next question is from Jeff Miller with Baird. Please proceed with your question.

Jeff Miller

Yes. Thank you for taking the question. Question on full service margin. So I hear you on seasonality and temp staffing cost on the other side of the APRA benefit. Is there anything else that’s worth calling out in the one that would potentially come to mind for me is anything on the Australia acquisition? I understand you’re excluding the transaction costs. But are there any, like upfront costs, severance onboard that lower margins? There was acquired deferred revenue write off of a month push and just anything else that would be unusual, that’s going into the back half margins?

Elizabeth Boland

Yes. It’s a good question. And I don’t think we want to have to – but we’re not just — don’t want to tell like we’re just given a litany of things that could be headwinds, but there are, we did have some — we have some integration costs with the Australian acquisition, which are not the transaction costs themselves, but just as you say, some costs of onboarding the team and whether it’s one time system conversions and things like that. So there’s about a million dollars, just under a million dollars in the second half that would be affecting the margins, a little bit of that continuing next year, but it would begin to abate as we complete the integration early in 2023. And the other thing I call out, Jeff, is that in the U.S. I think we’ve been experiencing, of course, some inflation, but the energy costs in the UK, and then Netherlands have been particularly high. And there’s smaller portions of our business, but they certainly are adding several million dollars to the second half of the year in terms of overall cost inflation that has the opportunity of people [ph] persisting and/ or abating if things settle down, a bit more in Europe. So that’s another headwind against that I call up.

Jeff Miller

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

Elizabeth Boland

So, we don’t really tend to pull out and quantify these smaller groups. But I’d say that once you’ve hit on an important element, which indicates camps have a very high utilization over the summer and the revenue actually falls away and they have intermittent camps, for different events for [Indiscernible] over the holidays, and school vacation times there are opportunities there, but it’s not the same intensity, as we experienced over the summer. So we certainly contributed several millions in revenue growth in the quarter, but that would be much more de minimis in Q4.

Jeff Miller

Okay. And then just last for me. Can you just talk through balance sheet management plans, just how you’re thinking about steady state leverage currently, kind of managing fixed versus floating exposure, etcetera given rising rates?

Elizabeth Boland

Sure. So we had obviously some significant investments in the third quarter with the acquisition of OAC and also has a substantial share repurchases. We’re About 3.5 term of depth right now. And that’s certainly a comfortable level for us given our EBITDA profile, et cetera. But we would be looking to sort of continue to grow into that at this point. We are looking at — we’ve always said that we go to the 2.5 to 3.5 times with our general leverage target and doing a significant acquisition, like always speaking of that is certainly something that is right in our strategy. And our debt is — we are seeing some escalation to the interest costs, but we do have caps on our debt, 80% of it, that is protecting us from the variability of interest rates. A portion of those caps roll off next fall and then we got sequential for restarting caps tail on after that. So we have our debt is essentially 80% to 90% covered and converted fixed with those caps in place in a little bit of [Indiscernible].

Jeff Miller

Very helpful. Thank you.

Elizabeth Boland

Thank you.

Stephen Kramer

Thank you.

Operator

Thank you. Our next Question is from Stephanie Moore with Jeffries. Please proceed with your question.

Unidentified Analyst

Hi. I’m [Indiscernible] in for Stephanie Moore. I was just wondering outside of financial services and healthcare, are you guys seeing any verticals where employer sponsored daycares getting to ramp, I guess a bit more than he thought and then just sort of what’s the sale cycle look like there?

Stephen Kramer

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

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

Unidentified Analyst

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

Elizabeth Boland

Yes. So as I just said, the primary we did some pretty significant capital investment in Q3 with our acquisition of Only About Children, and 180 million or so share repurchases. So, we are in adsorption digestion mode, certainly are continuing to look at smaller tuck-in acquisition opportunities. And we’ll continue to be judicious about those. But at this point, we are focused on growing enrollment and recovering in the primary based business. We have a number of lease models that are in development, and so those are new standard growth fits in this $35 million to $50 million of spend in the next 12 month period. And as a primary focus of capital allocation at the moment, and we’ll be paying down the revolver that we have outstanding. It’s about $100 million or so and, and that would be the near term view.

Unidentified Analyst

Got it. Thank you.

Elizabeth Boland

You are welcome.

Stephen Kramer

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

Elizabeth Boland

Thanks, everyone. Take care.

Operator

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

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